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SAN FRANCISCO-Leasing activity has slowed over the last several quarters but has been strong enough to keep vacancy falling and rents rising, according to a Colliers International third quarter market report. Net absorption was positive for the 13th consecutive quarter, soaking up 452,243 sf and pushing overall vacancy down 60 basis points to 10.5%.

Approximately three-quarters of the net absorption occurred in the city’s two financial districts, where direct vacancy now stands at 8.8%. The lack of supply in the districts has prompted a surge in rents. Since this time last year, average effective class A rents in the Financial District here have risen approximately 23% to $50.60 per sf while average class B rents have risen nearly 38% to $35.39 per sf.

While the number of deals quarterly held steady at 136, their aggregate size, 1.1 million sf, is 45% less than the second quarter, when total activity was two million sf, according to the report. Total leasing activity in the first quarter totaled 1.8 million sf.

In explaining the lack of larger deals, Colliers says the recently inflated asking rental rates imposed by the new wave of San Francisco landlords who paid top dollar for their properties could be the reason larger tenants are opting to hold off for the time being. The year-to-date average price per sf paid on class A assets is $650, up from $427 per sf in 2006, and $333 per sf in 2005.

Colliers also cites increased demand for view space as contributing to rising rents. The Venture Capital firm Artis Capital Partners in the third quarter to pay $100.50 per sf for its suite in One Market Plaza, according to the report. The rate is nearly twice the average paid for comparable space without a bay view.

Most notable of the few large leases signed during the quarter was a 104,000-sf lease by Salesforce.com that included a 35,000-sf renewal and a 32,000-sf expansion at One Market Plaza, and a 32,000-sf lease at One California St. that includes an option for two additional floors.

“The rise in actual rental rates is not as much a reflection of higher asking rents, but rather it’s a result of the demand for both office space with views and small suites,” says Colliers San Francisco managing director Scot Harper. “Currently, San Francisco has a limited quality supply of both relative to tenant demand.”

The “credit crunch” experienced in the residential sector now affects the commercial sector. Buyers are now required by lenders to contribute more equity, which negatively impacts traditionally high-leverage investors. The result created a number of “re-trades” in the market, which require financial assistance from sellers, and left low-leveraged buyers and all-cash buyers well positioned in negotiations with eager sellers, according to the report.

Notable class B assets that traded over the quarter included Lowe Enterprises’ sale of 300 California St. for $50 million to Kennedy Wilson; Broadreach Capital Partners’ acquisition of 550 Kearny St. from Bay Pacific Group for $58 million; and Page Mill Properties sale of 444 De Haro St. to Apollo Real Estate Advisors for $38 million. Significant class A acquisitions included Morgan Stanley’s flip of its 50% interest in One Market Street to Paramount Group Real Estate Fund III for $722 million; GE Capital’s purchase of 405 Howard St. for $247 million; and Blackstone’s sale of 650 Davis St. to Arden Realty for approximately $130.4 million.

“Over the next six months we will closely monitor the impact of the credit market’s recent fluctuations and how it affects the tenant demand from financial institutions, [hedge funds, investment banks, etc.] to see whether they expand or contract,” Harper says. “Fortunately the financial sector’s “wait and see” attitude is offset by the steady growth and demand by the technology sector of our market.”

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